Trade and Development: ISI and Economic Reform

Trade and Development: ISI and Economic Reform Oatley, Chapters 6 and 7

Ch. 4: Trade and Development I: Import-Substitution Industrialization • Mexico’s experiences • From ISI to GATT and NAFTA • Contrast with the previous era in which developing countries emphasized NIEO • Most countries have now dismantled protectionist systems they created in the first 30 years of the postwar period • Now they are active participants in the WTO • This chapter explores why countries had adopted protectionism • The next chapter focuses on the shift in policy

First we look at how governments came into power that supported import-competing interests • We then look at specific policies

Domestic Interests, International Pressures, and Protectionist Coalitions • Until WWI developing countries (that were independent) opted for liberal trade policies • They exported agricultural goods and other primary commodities and imported manufactured goods • By 1950s protectionism dominated trade policies (until the late 1980s) • Trade and development policies shaped by political competition between the country and the city • Rural-based agriculture versus urban-based manufacturing • Factor endowments (land abundant, capital poor countries, in general) • Thus, we see that GDP is dominated by agriculture and so are exports based on commodities and agriculture (see Tables 6.1 and 6.2) • Many countries were also monoexporters (one product)

Specific-factors model: limited factor mobility (2 sector model) • Agriculture is the export-oriented sector • Manufacturing is the import-competing sector • Landowners (of agricultural land) see incomes rise from trade but decline under protectionism • Manufacturers, by contrast, prefer protectionism • Urban interests: people who work for government, in retail, or in other non-manufacturing activities (nontraded-goods sector) • Some goods or services must be performed locally • International trade affects incomes in the nontraded-goods sector primarily through its impact on the prices of the traded goods that people employed in the nontraded-goods sector purchase

People employed in the nontraded-goods sector realize income gains from policies that reduce the prices of traded goods and losses from policies that raise the prices • ‘Oligarchic democracy’ in various Latin American countries contributed to the more liberal policies favored by agricultural interests • In Asia and Africa colonial structures ensured the dominance of export-oriented agricultural interests • Taiwan and Korea: enclave agriculture (result of Japanese colonization) – rice • India • Ghana: cocoa • But politics began to change in 20th century • Export-oriented interests gave way to interests of import-competing manufacturers • WWI: international economic shocks • Rationing of goods: difficult for Latin American countries to import goods from US or Europe • Falling commodity prices and disruption of trade patterns reduced foreign exchange

Trade barriers in Latin America was the response in order to produce many of the manufactured goods that they had previously imported • Growing urban middle class • Interest groups, industry based associations, and labor unions • New political coalitions based on support of the urban sectors • Juan Peron in Argentina in the 1940s; Gatulio Vargas in Brazil in 1950 • Political coalitions where incomes were based on import-competing manufacturing • Protectionism • India similar – led to Indian independence movement • Elsewhere in Asia, decolonization following defeat of Imperial Japan • Defeat of nationalist Chinese government (exiled to Taiwan) • Chinese nationalists imposed land reform in Taiwan • Korean War and the subsequent land reform • Africa decolonized only after 50s and early 60s (different: indigenous professional elites) • In total, transfer of control over existing economic practices from colonial governments to indigenous elites, so in Africa import-competing manufacturing played a smaller role in postindependence politics than did the nontraded-goods sector

The Structuralist Critique: Markets, Trade, and Economic Development • Structuralism • Belief that the market would not promote industrialization

Market Imperfections in Developing Countries • Belief that domestic market could not be expected to bring about the necessary shift of resources for industrialization • Market would not promote investment in manufacturing industries • 2 coordination problems that would limit investment • Complementary demand: not enough manufacturing for consumption (no single entrepreneur has an incentive to create a manufacturing enterprise • Pecuniary external economies: example of steel and auto industries • Big push: overcome the coordination problems • Economic planning

Market Imperfections in the International Economy • Singer-Prebisch theory: participation in GATT would make it harder for developing countries to industrialize by depriving them of critical resources • Core versus periphery • Terms of trade • Because in developing countries labor is strong, it will bargain with firms, but in developing countries productivity improvements are transformed into stable wages and falling prices for periphery-country commodities • Also, differences in income elasticity of demand for primary commodities versus industrial goods • Degree to which a change in income affects demand for a particular good • Low income elasticity of demand means that a large increase in per capita income produces little change in the demand of the particular good • Engel’s law holds that people spend smaller percentages of their total income on food and other primary commodities as the incomes rise • So, as incomes rise in the core countries, a smaller percentage of income will be spent on imports, but as incomes increase in periphery countries a larger percentage of those countries’ income will be spent on manufactured imports from the core • In other words, core countries captured most of the gains from trade

Domestic and International Elements of Trade and Development Strategies • State-led development strategies • Rapid industrialization • Seeking changes in the GATT-based trade system

Import Substitution Industrialization • Soviet Union as a model • Import substitution industrialization (ISI) • Substitute domestically produced goods for previously imported manufactured items • 2 stage stragey: • Easy ISI: simple consumer goods • Second stage: either export substitution strategy or Secondary ISI • Increasing percentages of local components mandated in the production of cars and other durable goods • Backward linkages: increases in demand in industries that supply components for the production of one good (e.g. cars) • Trade barriers, government planning, and investment policy • Infant-industry argument and lack of foreign exchange • Five year plans • State-owned enterprises (investment policies in targeted industries) • Meanwhile, trade boards controlled the price of agricultural produce • Tax on agricultural incomes (state could use to finance government-favored projects in industry) • Meanwhile, trade barriers served to raise domestic price of manufactured goods above the world price and people employed in agricultural sector paid a high price for manufactured goods • Thus, income was transferred from rural agriculture to urban manufacturing and nontraded-good sectors (ISI redistributed income) • Rapid economic growth

Reforming the International Trade System • Haberler Report • United Nations Conference on Trade and Development (UNCTAD) – 1964 • Group of 77 (G77) • Commodity price stabilization • GATT Part IV • Generalized System of Preferences (GSP) • OPEC • New International Economic Order (NIEO) • By mid-1980s the NIEO had fallen off the agenda • Heterogeneity of developing countries’ interests made it relatively easy for the advanced countries to divide the G77 by offering limited concessions to a small group of governments in exchange for defection from the broader group • By late 1970s many developing countries were facing serious balance-of-payments problems are were forced to turn to the IMF and World Bank for support

Ch. 7: Trade and Development II: Economic Reform • Export-oriented industrialization • Neoliberalism: highly skeptical of the state’s ability to allocate resources efficiently and places greater faith in the market’s ability to do so • Neoliberalism has greatly affected policy • Shift from structuralism to neoliberalism • ISI was generating economic imbalances • East Asian countries were outperforming others based on an export-led growth strategy • A severe economic crisis in the early 1980s forced governments to embark on reform • IMF and World Bank encouraged reform based on the neoliberal model

Emerging Problems with ISI • Persistent deficits • State-owned enterprises never became profitable • Domestic politics aggravated budget deficits • Politics of urban dwellers in nontraded-goods sector • Current account deficits (increasing demands for imports while reducing economy’s ability to export) • Demand for capital goods and inputs (an ironic byproduct of ISI) • Exports declined: non-competitive manufacturing industry and weakened agricultural sector • Overvalued exchange rates • But domestic politics made it difficult for governments to implement far-reaching reforms to remove the imbalances • Rent-seeking environment (higher than market return based on government intervention): inefficient and led to strong incentive to resist any efforts by the government to dismantle the system

The East Asian Model • Hong Kong, Singapore, South Korea, Taiwan outperformed other developing countries • Rate of per capita growth • Manufacturing growth rapid • Exports grew rapidly • Export-oriented strategy • Experts disagree on whether to emphasize the role of the state or the market in explaining the success of East Asian economies • IMF/World Bank interpretation versus the East Asian Model of Development (stages of industrialization argument) • In East Asian model government policy drives industrialization from initial low-skilled, labor intensive production to capital-intensive forms of production and from there to industries that rely on high-skilled labor and research and development • Objectives: reduce cost of investment funds, create incentives to export, protect infant industries, and promote the acquisition and application of skills

Structural Adjustment and the Politics of Reform • Economic crises of 1980s • International shocks (price of oil, reduction in the terms of trade between primary commodities and manufactured goods, and higher interest rates on the foreign debt accumulated) • IMF • Structural Adjustment Programs • Privatization • Expectation: reduce average incomes and redistribute income across groups, with faster growth and higher average incomes in the long run • Economic costs triggered a realignment of interests, discrediting groups associated with the old regime • New political consensus for new strategy to be adopted • Incremental reform • Estimates suggest that growth rates in 1980s and 1990s were higher than what would have been the case if reforms had not been implemented

Developing Countries and the WTO • Developing countries have a comparative advantage in agriculture and textiles but face obstacles from advanced countries • Tariffs, agricultural subsidies, tariff escalation, protectionism in textile and apparel industries • Introduction of notion of core labor standards in WTO • Success at Doha round? • G20 • Or less optimistic?

Trade and Development: ISI and Economic Reform